Chevron and ExxonMobil claim their announced mergers with Hess and Pioneer take advantage of market efficiencies, but a closer look reveals an antiquated tax provision likely sweetening these dangerous deals. Antitrust authorities must carefully review the serious risks entailed in these proposed mergers. In parallel, the United States federal government needs to end large tax-free reorganizations—the most egregious way in which American taxpayers are subsidizing monopolistic practices, writes Niko Lusiani.
In the latest scramble over diminishing oil reserves, Chevron and ExxonMobil’s recently announced acquisitions of smaller competitors Hess and Pioneer shocked energy markets. The two largest oil mergers in a decade (respectively for $60 billion and $64.5 billion) will further concentrate the power to dictate oil production and prices into the hands of Big Oil incumbents and encourage further market consolidation from competitors. The deals are likely to further lock in investments in harmful fossil fuel-based energy sources rather than expand real renewables. Observers argue that further consolidation would also supercharge Big Oil’s political power in the United States, threatening to flood politics with even more lobbying (the industry spent $124.4 million on lobbying in 2022) and media manipulation to undermine democracy.
In the face of these dangers, Chevron, Hess, Exxon, and Pioneer executives extol the mergers for their operational and financial efficiencies. Yet, an antiquated tax provision hidden in plain sight is likely an unexplored driver of these and many other large mergers.
Under a century-old federal tax provision (Section 368 of the Internal Revenue Code), corporations and shareholders can defer (often indefinitely) paying tax on gains from certain types of mergers and acquisitions. Such tax-free reorganizations are often structured as all-stock acquisitions like those of both Chevron-Hess and Exxon-Pioneer. Among other tax savings, such deals allow the founder CEOs of the acquired companies to swap stock in their old firms for stock in the acquiring firms, with tax liability for all the accumulated capital gains deferred until realization. If passed on to their families at death, federal tax on these sizable capital gains is avoided altogether.
Just ask yourself: With bountiful cash on hand from price run ups last year, why would oil supermajors decide to dilute their stock by offering all-equity deals to acquire competitors rather than just pay cash? One reason the Hess family may have been sold by the deal, according to one observer, is that “the deal is all-stock and therefore tax efficient, which may have appealed to the Hess family, led by CEO John Hess. The family owns about 10% of Hess stock.”
Indeed, the Hess family, which founded the firm in 1933, now has a $5 billion equity stake, according to Bloomberg. Chevron’s all-stock offer—likely structured as a tax-free reorganization—could mean that much of those five billion dollars in capital gains will go untaxed in this transaction. For once passed on to heirs, that growth in wealth would be ignored for federal tax purposes through the “angel of death” loophole. By accepting Chevron’s all-stock deal, the Hess family may have saved itself a cool $1 billion in capital gains tax compared to an all-cash deal (For simplicity, this assumes a top-end capital gains tax rate of 20%). That $1 billion is enough, for example, to kickstart public solar start-ups like Public Solar NYC and deliver clean, free electricity in a hundred cities across the U.S.
As for Exxon’s recent all-stock acquisition, Pioneer was founded by CEO Scott Sheffield in 1997, and is now valued at roughly $60 billion. Sheffield himself will reportedly receive at least $151 million worth of Exxon stock, and so could receive something like a $30 million break in capital gains tax by structuring this deal as a tax-free reorganization.
Big Oil is not alone in utilizing tax-free reorganizations. While undiscussed outside of Big Law and accounting firms, tax-free reorganizations are fairly common, especially amongst large M&A deals. Since 2007, around a third of the aggregate value of all U.S. mergers have been structured to be fully or in part tax-free, according to Bloomberg Law. In 2021, a greater proportion of large mergers (52% of deals over $1 billion) were tax-free.
Indeed, some of the most notable M&A deals of recent history may have been driven—at least partly—by a search for corporate and individual tax savings. Google acquired YouTube, for example, through a tax-free transfer of Google stock to the founders of the then two-year-old startup, deferring individual and corporate capital gains taxes on as much as $1.65 billion of capital gains in a single deal. The Facebook acquisition of WhatsApp and the Time Warner deal for Discovery are just two other notable tax-free reorganizations.
Supporters of tax-free reorganizations argue that firms and their shareholders shouldn’t face tax consequences for mere formal changes to business structure where no cash realization occurred. Swapping stock or assets, it’s argued, is simply “old wine in a new [bigger] bottle,” with no material changes to the underlying business. Yet, if the M&A deal provides no real boost to the merged firms’ economics, and provides no financial incentives to shareholders or senior management, why would the CEOs decide to consummate the deal to begin with? It stretches the imagination to say that Google’s acquisition of YouTube or Facebook’s purchase of WhatsApp didn’t expand those firms’ market shares and profit margins handsomely.
Large tax-free mergers and acquisitions shouldn’t need the helping hand of everyday taxpayers. They are a wasteful boon for CEO founders and other concentrated shareholders. Diverging tax treatment also distorts markets by incentivizing certain types of mergers over others. Even more worrying, tax-free reorganizations can directly incentivize corporate consolidation—one of the most egregious ways in which the U.S, tax code subsidizes monopolistic practices.
Large tax-free reorganizations must end. Congress should immediately set out to write and pass new legislation toward that aim. The Federal Trade Commission and the Department of Justice should conduct a comprehensive study into the federal tax code’s impact on market concentration, with a particular emphasis on past and pending tax-free reorganization deals. The step-up in basis, or “angel of death,” loophole encourages dynastic wealth hoarding and should be ended for the top-end tax bracket. Considering the real risks posed by consolidation in the oil&gas industry, the antitrust agencies should carefully review and investigate the Exxon-Pioneer and Chevron-Hess deals.
Affordable energy, a stable climate, and a functioning democracy may depend on it.
Disclosure: The author works for the Roosevelt Institute, which receives funding from organizations like the Ford Foundation, William and Flora Hewlett Foundation, Omidyar Network, and Open Society Foundations. Read more about our disclosure policy here.
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